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Toward a Better Buy-Sell Agreement

February 5, 2015Business succession planning: Encourage your clients to get it done | New Jersey Law JournalAttorney: Steven M. Saraisky

Business succession planning is a growth area for trust and estate and transactional attorneys, driven largely by the demographics of the Baby Boomer generation, which is now at retirement age. Buy-sell agreements are among the most important transactions that a business owner will enter into. Yet many, even most, businesses do not have a good or up-to-date buy-sell agreement in place. This article is intended to be a high level, nontax discussion of some of the best practices we like to employ to provide a client with "a better buy-sell agreement."

Get It Done; Get It Updated

One of the hazards of a trust and estate practice is clients' general reluctance to address issues related to death, taxes, difficult fiduciary choices and more. In the same way, business owners are generally reluctant to address succession planning. It can be a difficult process, and clients erect many psychological barriers to completing it. The attorney's job is to get the client over the finish line with these agreements. We perform a very valuable service to our clients when we do just that. Here are some tips and approaches that may help you help your clients to complete the business succession process:

Schedule regular meetings to discuss business succession issues, recognizing that it is a process that plays out over months or years, rather than days or weeks. If the agreement is not complete, at least make sure the next meeting is on the calendar for all interested parties.

Ask open-ended questions about what the business owner wants, and listen to answers before committing to any specific plan. Questions include: • What are the business owner's long-term goals for the business? • What are the financial needs of the owner and spouse? What is the plan that ensures these needs will be satisfied? • What would be an ideal management succession plan (who runs the business)? • What would be an ideal ownership succession planning (who owns the business)? Do not draft documents until the answers to these questions (and the issues they may raise) are well understood.

Create a sense of urgency by discussing potential bad outcomes. Questions to discuss with the client may include: • If you die suddenly, what happens to your ownership interest? • If your partner gives himself or herself a large raise after your death, can anyone practically object? • If you die without an agreement in place, do you expect that your grieving, financially unsophisticated spouse will negotiate a fair buyout with your notoriously difficult business partner? • If you become disabled and cannot work, how long should your salary continue at its current level? • If your partner becomes disabled and cannot work, how long should his or her salary continue at its current level? • If you wanted to retire, what would happen to your shares? To your salary and benefits? • How long would it take to sell the business to an outsider? • Are you confident a third-party buyer can even be found for the business? • Could a sale, as required pursuant to a buy-sell agreement, eliminate this risk?

Revisit old agreements to make sure they are updated. Run hypotheticals as if a trigger event had occurred. If all parties believe that the process is clear and not subject to different interpretations, the value of the business established under the agreement is fair, and the required payments can be completed on time, then the agreement works. More often than not, this test demonstrates that the agreement should be updated.

Get Specific

Boilerplate buy-sell agreements often lead to complications. True, it takes time, but the more specific the parties can be, the better the agreement. The agreement can specify whether a buyout is mandatory or optional, the terms of payments, including interest rate and term for any notes, and whether the owner's perks like cars and health benefits will continue, and more. If possible, the agreement should address divorce, disability and retirement in addition to death. Consider addressing both disability income and disability buyout of shares (and funding in situations where there is no life insurance payment). Consider the possibility of multiple owners retiring at the same time. Consider distinguishing between normal retirement and early or unexpected retirement. Identify the specific insurance policies to be maintained in connection with the buy-sell. Provide for annual confirmation to all parties that the policies remain in force. Specify what happens to the unused policies after a buyout takes place.

Clearly Define the Valuation Method

The value of an owner's interest is generally determined in one of three ways: (1) a fixed value (e.g., certificate of agreed value approach); (2) a formula approach (e.g., one times sales or three-to-five times EBITDA); or (3) an appraisal. Fixed value agreements often become outdated, although lawyers can address this by meeting with their clients annually or biannually and updating the agreed values (it is good for business—why don't more lawyers do it?). Requiring an appraisal has the disadvantage of adding a cost, but generally appraisals produce a more realistic market value. The agreement can specify whether valuation discounts for lack of control or marketability should be taken into account. The agreement can specify whether the value of ownership interests should be tax-effected.

Create a Management Succession Plan

Management succession planning means identifying, training and then transitioning the day-to-day operation of the business. It is often overlooked by attorneys, yet it is an area where we can provide great value simply by pressing the business-owner client to address it. Common obstacles in this area include owners who refuse to relinquish control, sibling rivalries, other family problems, promotions based on bloodline rather than merit, and competing advisors. The attorney (often in the role of family psychologist) can help the client address most of these. Management succession planning may be addressed in a buy-sell agreement, but also can be addressed in additional legal documents, including employee agreements, voting and non-voting ownership interests, trust arrangements or even put and call options. In some businesses, if a management succession plan cannot be achieved, it may be better to sell the business and attempt to get maximum value for it from a third party rather than proceed with poor management in the future.

Troubleshoot the Difficult Issues

And review them with the client until an acceptable approach is agreed upon. Sometimes it makes sense to address the easier issues first, build consensus and momentum, and then address the difficult issues last when there is already agreement on the previous issues. Common difficult issues include: the structure for management decisions, providing sufficient or certain income to a surviving spouse without suffocating the business, equalization among children in the business and children not in the business, and providing incentives for key employees. At times, it may be preferable to reach an acceptable resolution rather than try and fail to reach a perfect resolution.

Avoid Conflicts of Interest by Clearly Identifying Your Client

New Jersey Rule of Professional Conduct 1.7 governs concurrent conflicts of interest in New Jersey. To paraphrase the rule, a concurrent conflict exists if: (1) representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client, a third person or by the lawyer's personal interest. The rule requires the attorney to exercise careful judgment about whether the representation will be materially limited due to the conflict.

The risks that the attorney must consider include: (1) that the attorney or advice is compromised because of the conflicting loyalties; (2) that the attorney cannot keep confidential information from one of the parties; and (3) the loss of attorney-client privilege if an actual dispute develops between the clients. If a concurrent conflict exists, a lawyer can still represent a client if: (1) each affected client gives informed consent, confirmed in writing; and (2) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client.

Therefore, it is important to obtain conflict waiver letters in many situations. When appropriate, the attorney should remind the parties whom he or she does not represent in writing of their right to get their own counsel.

The attorney can provide great value to a business owner client by focusing at a high level on the business succession process and the important terms of a buy-sell agreement as described in this article.

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